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Monetary Policy Transmission with Interbank Market Fragmentation

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  • MIKLOS VARI

Abstract

This paper shows how interbank market fragmentation disrupts the transmission of monetary policy. Fragmentation is the fact that banks, depending on their country of location, have different probabilities of default on their interbank borrowings. Once fragmentation is introduced into standard theoretical models of monetary policy implementation, excess liquidity arises endogenously. This leads short‐term interest rates to depart from the central bank policy rates. Using data on monetary policy operations, I show that this mechanism has been at work in the euro area since 2008. The model is used to analyze conventional and unconventional monetary policy measures.

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  • Miklos Vari, 2020. "Monetary Policy Transmission with Interbank Market Fragmentation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(2-3), pages 409-440, March.
    • Handle: RePEc:wly:jmoncb:v:52:y:2020:i:2-3:p:409-440
    DOI: 10.1111/jmcb.12604
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    1. Eric Monnet & Miklos Vari, 2023. "A Dilemma between Liquidity Regulation and Monetary Policy: Some History and Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(4), pages 915-944, June.
    2. Eric Monnet & Miklos Vari, 2019. "Liquidity Ratios as Monetary Policy Tools: Some Historical Lessons for Macroprudential Policy," IMF Working Papers 2019/176, International Monetary Fund.
    3. Marie‐Hélène Gagnon & Céline Gimet, 2023. "One size may not fit all: Financial fragmentation and European monetary policies," Review of International Economics, Wiley Blackwell, vol. 31(1), pages 305-340, February.
    4. Luigi Bonatti & Andrea Fracasso & Roberto Tamborini, 2021. "Unconventional Policy Instruments and Transmission Channels:A State-Contingent Toolbox for the ECB," DEM Working Papers 2021/05, Department of Economics and Management.
    5. Popoyan, Lilit & Napoletano, Mauro & Roventini, Andrea, 2020. "Winter is possibly not coming: Mitigating financial instability in an agent-based model with interbank market," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).
    6. Aref Mahdavi Ardekani & Isabelle Distinguin & Amine Tarazi, 2019. "Interbank network characteristics, monetary policy "News" and sensitivity of bank stock returns," Working Papers hal-02384533, HAL.
    7. Thibaut Piquard & Dilyara Salakhova, 2019. "Secured and Unsecured Interbank Markets: Monetary Policy, Substitution and the Cost of Collateral," Working papers 730, Banque de France.
    8. Silvia Gabrieli & Claire Labonne, 2018. "Bad Sovereign or Bad Balance Sheets? Euro Interbank Market Fragmentation and Monetary Policy, 2011-2015," Supervisory Research and Analysis Working Papers RPA 18-3, Federal Reserve Bank of Boston.
    9. Dr. Lucas Marc Fuhrer & Dr. Matthias Jüttner & Jan Wrampelmeyer & Matthias Zwicker, 2021. "Reserve tiering and the interbank market," Working Papers 2021-17, Swiss National Bank.
    10. Bruno de Menna, 2021. "Monetary Policy, Credit Risk, and Profitability: The Influence of Relationship Lending on Cooperative Banks' Performance," Working Papers hal-03138738, HAL.
    11. Benoit Nguyen & Davide Tomio & Miklos Vari, 2023. "Safe Asset Scarcity and Monetary Policy Transmission," Working papers 934, Banque de France.
    12. Arrata, William & Nguyen, Benoît & Rahmouni-Rousseau, Imène & Vari, Miklos, 2020. "The scarcity effect of QE on repo rates: Evidence from the euro area," Journal of Financial Economics, Elsevier, vol. 137(3), pages 837-856.
    13. Mody, Ashoka & Nedeljkovic, Milan, 2024. "Central bank policies and financial markets: Lessons from the euro crisis," Journal of Banking & Finance, Elsevier, vol. 158(C).
    14. Anindya Banerjee & Victor Bystrov & Paul Mizen, 2017. "Structural Factor Analysis of Interest Rate Pass Through In Four Large Euro Area Economies," Working Papers in Economics 17/07, University of Canterbury, Department of Economics and Finance.
    15. Emilie Da Silva & Vincent Grossmann-Wirth & Benoit Nguyen & Miklos Vari, 2021. "Paying Banks to Lend? Evidence from the Eurosystem's TLTRO and the Euro Area Credit Registry," Working papers 848, Banque de France.

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